Chapter Two
External Analysis:
The Identification of Opportunities
and Threats
External Analysis
The purpose of external analysis is to identify the strategic opportunities and threats in the
organization’s operating environment that will affect how it pursues its mission.
External Analysis requires an assessment of:
❖ Industry environment in which company operates
• Competitive structure of industry
• Competitive position of the company
• Competitiveness and position of major rivals
❖ The country or national environments in which company competes
❖ The wider socioeconomic or macro environment that may affect the company and its
industry
• Social
• Government
• Legal
• International
• Technological
External Analysis: Opportunities and Threats
Analyzing the dynamics of the industry in which an organization
competes to help identify:
Opportunities Threats
Conditions in the environment
Conditions in the environment that
that a company can take
endanger the integrity and
advantage of to become more
profitability of the company’s
profitable
business
Industry Analysis: Defining an Industry
❖ Industry
• A group of companies offering products or services that are close
substitutes for each other and that satisfy the same basic customer needs
• Industry boundaries may change as customer needs evolve and
technology changes
❖ Sector
• A group of closely related industries
❖ Market Segments
• Distinct groups of customers within an industry
• Can be differentiated from each other with distinct attributes and specific
demands
Industry analysis begins by focusing on the overall industry before
considering market segment or sector level issues
The Computer Sector:
Industries and Market Segments
Porter’s Five Forces Model Figure 2.2
① Risk of Entry by Potential Competitors
Potential Competitors are companies that are not currently competing in an
industry but have the capability to do so if they choose. Barriers to new entrants
include:
1. Economies of Scale – as firms expand output unit costs fall via:
❖ Cost reductions – through mass production
❖ Discounts on bulk purchases – of raw material and standard parts
❖ Cost advantages – of spreading fixed and marketing costs over large volume
2. Brand Loyalty
❖ Achieved by creating well-established customer preferences
❖ Difficult for new entrants to take market share from established brands
3. Absolute Cost Advantages – relative to new entrants
❖ Accumulated experience – in production and key business processes
❖ Control of particular inputs required for production
❖ Lower financial risks – access to cheaper funds
4. Customer Switching Costs for Buyers – where significant
5. Government Regulation
❖ May be a barrier to enter certain industries
② Rivalry Among Established Companies
Competitive Rivalry refers to the competitive struggle between companies in the same
industry to gain market share from each other. Intensity of rivalry is a function of:
1. Industry Competitive Structure
❖ Number and size distribution of companies
❖ Consolidated versus fragmented industries
2. Demand Conditions
❖ Growing demand – tends to moderate competition and reduce rivalry
❖ Declining demand – encourages rivalry for market share and revenue
3. Cost Conditions
❖ High fixed costs – profitability leveraged by sales volume
❖ Slow demand and growth – can result in intense rivalry and lower profits
4. Height of Exit Barriers – prevents companies from leaving industry
❖ Write-off of investment in assets ❖ High fixed costs of exit
❖ Economic dependence on industry ❖ Emotional attachment to industry
❖ Maintain assets - to participate
❖ Bankruptcy regulations – allowing unprofitable assets to remain
effectively in an industry
③ Bargaining Power of Buyers
Industry Buyers may be the consumers or end-users who ultimately use the
product or intermediaries that distribute or retail the products. These buyers are
most powerful when:
1. Buyers are dominant.
❖ Buyers are large and few in number.
❖ The industry supplying the product is composed of many small companies.
2. Buyers purchase in large quantities.
❖ Buyers have purchasing power as leverage for price reductions.
3. The industry is dependent on the buyers.
❖ Buyers purchase a large percentage of a company’s total orders.
4. Switching costs for buyers are low.
❖ Buyers can play off the supplying companies against each other.
5. Buyers can purchase from several supplying companies at once.
6. Buyers can threaten to enter the industry themselves.
❖ Buyers produce themselves and supply their own product.
❖ Buyers can use threat of entry as a tactic to drive prices down.
④ Bargaining Power of Suppliers
Suppliers are organizations that provide inputs such as material and labor into
the industry. These suppliers are most powerful when:
1. The product supplied is vital to the industry and has few substitutes.
2. The industry is not an important customer to suppliers.
❖ Suppliers are not significantly affected by the industry.
3. Switching costs for companies in the industry are significant.
❖ Companies in the industry cannot play suppliers against each other.
4. Suppliers can threaten to enter their customers’ industry.
❖ Suppliers can use their inputs to produce and compete with companies already in the
industry.
5. Companies in the industry cannot threaten to enter suppliers’ industry.
⑤ Substitute Products
Substitute Products are the products from different businesses or industries that
can satisfy similar customer needs.
1. The existence of close substitutes is a strong competitive threat.
❖ Substitutes limit the price that companies can charge for their product.
2. Substitutes are a weak competitive force if an industry’s products have few close
substitutes.
❖ Other things being equal, companies in the industry have the opportunity to raise prices
and earn additional profits.
Strategic Groups Within Industries
Strategic Groups are groups of companies that follow a business model
similar to other companies within their strategic group – but are different
from that of other companies in other strategic groups.
The basic differences between business models in different strategic groups
can be captured by a relatively small number of strategic factors.
❖ Implications of Strategic Groups –
1. The closest competitors are within the same Strategic Group and may be viewed by
customers as substitutes for each other.
2. Each Strategic Group can have different competitive forces and may face a different set of
opportunities and threats.
❖ Mobility Barriers – factors within an industry that inhibit the movement of companies
between strategic groups
• Include barriers to enter another group or exit existing group
Figure 2.3
Strategic Groups in the Pharmaceutical Industry
Industry Life Cycle Analysis
Industry Life Cycle Model analyzes the affects of industry evolution on competitive
forces over time and is characterized by five distinct life cycle stages:
1. Embryonic – industry just beginning to develop
⮲ Rivalry based on perfecting products, educating customers, and
opening up distribution channels.
2. Growth – first-time demand takes-off with new customers
⮲ Low rivalry as focus is on keeping up with high industry growth.
3. Shakeout – demand approaches saturation, replacements
⮲ Rivalry intensifies with emergence of excess productive capacity.
4. Mature – market totally saturated with low to no growth
⮲ Industry consolidation based on market share, driving down price.
5. Decline – industry growth becomes negative
⮲ Rivalry further intensifies based on rate of decline and exit barriers.
Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves
❶ ❷ ❸ ❹ ❺
Growth in Demand and Capacity
Anticipate how forces will change and formulate appropriate strategy Figure 2.5
Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity
Limitations of Models for Industry Analysis
❖ Life Cycle Issues
• Industry cycles do not always follow the life cycle generalization.
• In rapid growth situations embryonic stage is sometimes skipped.
• Industry growth revitalized through innovation or social change.
• The time span of the stages can vary from industry to industry.
❖ Innovation and Change
• Punctuated Equilibrium occurs when an industry’s long term stable structure is punctuated with
periods of rapid change by innovation.
• Hypercompetitive industries are characterized by permanent and ongoing innovation and
competitive change.
❖ Company Differences
• There can be significant variances in the profit rates of individual companies within an industry.
• In addition to industry attractiveness, company resources and capabilities are also important
determinants of its profitability.
Models provide useful ways of thinking about competition within an industry – but be aware
of their limitations.
Punctuated Equilibrium and Competitive Structure
The Role of the Macroenvironment
Changes in the forces in the
macro-environment can directly
impact:
• The Five Forces
• Relative Strengths
• Industry Attractiveness
